Last week's profit announcement from Nahar Spinning Mills Limited (NSE:NAHARSPING) was underwhelming for investors, despite headline numbers being robust. We did some digging and found some worrying underlying problems.
A Closer Look At Nahar Spinning Mills' Earnings
One key financial ratio used to measure how well a company converts its profit to free cash flow (FCF) is the accrual ratio. The accrual ratio subtracts the FCF from the profit for a given period, and divides the result by the average operating assets of the company over that time. You could think of the accrual ratio from cashflow as the 'non-FCF profit ratio'.
That means a negative accrual ratio is a good thing, because it shows that the company is bringing in more free cash flow than its profit would suggest. While having an accrual ratio above zero is of little concern, we do think it's worth noting when a company has a relatively high accrual ratio. That's because some academic studies have suggested that high accruals ratios tend to lead to lower profit or less profit growth.
Nahar Spinning Mills has an accrual ratio of 0.24 for the year to September 2021. We can therefore deduce that its free cash flow fell well short of covering its statutory profit. In the last twelve months it actually had negative free cash flow, with an outflow of ₹954m despite its profit of ₹3.20b, mentioned above. Coming off the back of negative free cash flow last year, we imagine some shareholders might wonder if its cash burn of ₹954m, this year, indicates high risk.
Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Nahar Spinning Mills.
Our Take On Nahar Spinning Mills' Profit Performance
Nahar Spinning Mills didn't convert much of its profit to free cash flow in the last year, which some investors may consider rather suboptimal. Because of this, we think that it may be that Nahar Spinning Mills' statutory profits are better than its underlying earnings power. The good news is that it earned a profit in the last twelve months, despite its previous loss. At the end of the day, it's essential to consider more than just the factors above, if you want to understand the company properly. If you'd like to know more about Nahar Spinning Mills as a business, it's important to be aware of any risks it's facing. Case in point: We've spotted 4 warning signs for Nahar Spinning Mills you should be mindful of and 2 of these are a bit unpleasant.
Today we've zoomed in on a single data point to better understand the nature of Nahar Spinning Mills' profit. But there are plenty of other ways to inform your opinion of a company. For example, many people consider a high return on equity as an indication of favorable business economics, while others like to 'follow the money' and search out stocks that insiders are buying. While it might take a little research on your behalf, you may find this free collection of companies boasting high return on equity, or this list of stocks that insiders are buying to be useful.
This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.
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